Francesca Freed wants a Burg-N-Fry franchise. The buy-in is $500,000. Burg-N-Fry headquarters tells Francesca that typical annual operating costs are $160,000 (cash) and that she can bring in “as much as” $260,000 in cash revenues per year. Burg-N-Fry headquarters also wants her to pay 10% of her revenues to them per year. Francesca wants to earn at least 8% on the investment, because she has to borrow the $500,000 at a cost of 6%. Use a 12-year window, and ignore taxes.
REQUIRED
1. Find the NPV and IRR of this investment, given the information that Burg-N-Fry has given Francesca.
2. Francesca is nervous about the “as much as” statement from Burg-N-Fry, and worries that the cash revenues will be lower than $260,000. Repeat requirement 1 using revenues of $240,000 and $220,000.
3. Francesca thinks she should try to negotiate a lower payment to the Burg-N-Fry head- quarters, and also thinks that if revenues are lower than $260,000, her costs might also be lower by about $10,000. Repeat requirement 2 using $150,000 as annual cash operating cost and a payment to Burg-N-Fry of only 6% of sales revenues.
4. Discuss how the sensitivity analysis will affect Francesca’s decision to buy the franchise. Why don’t you have to recalculate the internal rate of return if you change the desired (discount) interest rate?